Budget 2018: Bond markets sold off sharply on Thursday spooked by higher than expected fiscal deficit estimates and fears that food inflation would rise with stronger support for crop prices via minimum support prices (MSP).
Budget 2018: Bond markets sold off sharply on Thursday spooked by higher than expected fiscal deficit estimates and fears that food inflation would rise with stronger support for crop prices via minimum support prices (MSP). The yield on the old benchmark bonds—6.79% yielding notes maturing in 2027—soared an unprecedented 20 basis points to close at 7.80%. The yield on the benchmark jumped 17 basis points to hit 7.60%, a 22-and-a half-month high, with markets fearing a more hawkish stance from the Reserve Bank of India (RBI). The government announced the revised fiscal deficit estimate for FY18 at 3.5% of GDP and projected the fiscal deficit for FY19 at 3.3%—higher than its previous target of 3% for next fiscal.
Manish Wadhawan, Head – Fixed Income, Global Markets at HSBC India, indicated that the market reacted negatively to the fiscal slippage in the current year as well as the increase in FY19 guidance. “This has upset bond market expectations. Also, it has come on the back of underlying pressures that have been brewing in the market on account of high oil prices and the sell-off in the global rates markets,” he said. Finance minister Arun Jaitley stated in his Union Budget 2018 speech said that the government has decided to keep the MSP for all the unannounced crops of kharif at least at one and half times of their production cost. “If price of the agriculture produce market is less than MSP, then in that case government should purchase either at MSP or work in a manner to provide MSP for the farmers through some other mechanism,” he announced.
Market participants believe that the central bank, which is already cautious, might get hawkish going forward. They now see a higher possibility of a rate hike, as a rise in MSP can impact food prices and rural consumption—both of which could push up food inflation. This could, in turn, result in a rise in retail inflation as food forms 46% of the consumer price index (CPI). Jayesh Mehta, India country treasurer, Bank of America Merrill Lynch, observes that in a market cluttered with negative sentiment, any news with a tinge of caution could be taken very seriously. “Nobody knows whether the increase in MSP will actually fuel food inflation, but the market is reacting strongly to this announcement, expecting the RBI to be more hawkish in the next policy review,” he said.
Mehta also observes that there is a big demand-supply mismatch in the market. “Although the net borrowing figure for FY19 is almost similar to that of FY18, the market seems to be worried about the supply because we have limited investors in the market. Unless the RBI steps in with OMO purchases or by raising the FPI limits, the absorption of such a large supply remains a cause of concern,” he said. The net borrowing figure for FY19 is projected at `4.62 lakh crore. Some experts also believe that aggressive revenue projections by the government also pose an upward risk to the fiscal deficit target for the next fiscal. Ananth Narayan, professor-finance at SPJIMR, argues that the Budget math is yet to be fully digested by the market, and the fear is that the revenue projections at 17% may be aggressive.
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“The market anyway fears the possibility of fiscal and CPI slippage, given uncertainty of global energy and oil prices. The possible inflationary impact of the budget, and the possibility of further fiscal slippage added to the woes of a market that has anyway been depressed since late December 2017,” he added. Meanwhile, the rupee plunged 44 paise to close at a near two-week low of 64.02 against the US dollar after the government announced long-term capital gains tax on equities and widened its fiscal deficit target while unveiling the Budget.